Why property leases need a makeover

Affordable housing is out the window. What’s needed are some cosmetic changes to residential property leases.

PORTFOLIO POINT: Introducing some features of commercial property leases to the residential sector would brighten the outlook for investors and tenants.

Australian home ownership rates are among the highest in the world, sitting at around 70% of all households.

Ever since the 1940s, when Robert Menzies made his famous “forgotten people” speech praising the aspirational middle classes, home ownership has almost become embedded into the Australian psyche to the point where we treat it as one of our life key goals.

Now whilst it is reasonable to associate home ownership with shelter and security, as a nation we’ve arguably imbued owning a home with too much significance. By putting owning a home on a pedestal we’ve diminished the legitimacy of renting, casting it as the lesser of the two ways to secure accommodation.

That concerns me. In the first instance, the subtle social stigma associated with renting – for example, the suggestion that rent money is dead money – is offensive to those who choose to rent rather than own, especially first home buyers who are often cash and equity challenged. Moreover, I believe we have to make friends with the fact that the proportion of Australians renting will grow over coming years because unaffordability is fast becoming the norm.

Whilst we’d all like to wish for better affordability, it isn’t going to happen unless there is a major crash, and that isn’t on the cards. And even Glenn Stevens was clear on that point in a speech last week. “The ingredients we would look for as signalling an imminent crash seem, if anything, less in evidence now than five years ago,” he said.

Changing the rental lease landscape

Can we address low affordability from a different direction? Perhaps the answer is to seek to increase the appeal and demand for rental accommodation by giving tenants greater security. If successful, this will reduce the demand to buy in certain market sectors and this may improve affordability. The challenge is to reshape the dynamics of the rental market so that it becomes a more attractive option and gives tenants greater security whilst simultaneously maintaining investors’ position.

In light of the fact that most leases in Australia tend to be relatively short term – around 12 months – establishing longer-term leases may address the sense of impermanence that some renters who would prefer to be home owners feel at the moment. Currently, residential leases are either renewed every 12 months or default to a month-by-month lease. This is in stark contrast to the commercial sector, where tenants and investors negotiate multi-year leases, with a first-refusal option for the tenant to renew thereafter.

One of the certainties of commercial leases is that the frequency and rate of rent rise is stipulated in the contract drawn up at inception. Typically, a rent rise will occur once a year at the level of CPI or by a nominated amount.

Whilst this provides commercial tenants with some visibility and certainty about future leasing costs, Stuart Bonning, owner of Bonning Property, warns that there are limits to what can be controlled. “At the end of the lease, including when there is an option to renew, commercial tenants are usually subjected to an open market review of the rent. That means the investor could conceivably raise the rent by whatever they think the market can bear.”

Indeed, in this respect, Bonning sees the residential sector as already having greater protections for tenants. “Residential leases are highly regulated. Tenants can challenge ‘unreasonable’ rent rises through the legal system.”

I see merit in a system that takes the best aspects from commercial and residential leases, whereby tenants and investors could agree to leases of say, up to five years and where rental increases were tied to the rate of inflation, for example.

Room for improvements

Longer leases could also pave the way for relaxing the rules on tenants undertaking modest cosmetic renovations of their property. At the moment, one generally can’t personalise a rental property beyond hanging a few pictures. A little more flexibility here would certainly engender a greater sense of connection to a property without it unduly affecting investors.

Commercial tenants are offered great scope to modify their property, with complete fit-outs common place. The golden rule is that tenants have to ‘make good’ any changes they’ve made at the end of the lease, according to Bonning. “If a tenant takes an empty shell and does a full fit out, the landlord is within their rights to demand every fitting and fixture is removed at the end of the lease,” he says. Similar requirements could be applied to the residential sector if leases were long term.

There are lessons from other residential markets. Rachel Wood, a broker at Sotheby's International Realty in Manhattan, New York says that many landlords in New York City do allow tenants to decorate. “Whilst you can’t change the permanent structure of the apartment, painting is often allowed and, on occasion, tenants have even put in temporary pressurised walls to create more rooms. These requests have to be put in writing and you may have to pay a little more rent to access this option.”

I would welcome an initiative that allowed those tenants holding longer leases the option to undertake some modest cosmetic work, as long as an obligation was placed on the tenant to re-instate the original state of the apartment – at their own cost – once they vacated the property. And tenants need to remember that with rents at around 4% of market value it’s significantly cheaper to rent than pay a hefty mortgage at 6-7% of the loan value.

I understand that many investors may not feel any compulsion to innovate at this stage, given that most of the states’ real estate institutes are reporting low vacancy rates. However, the upsides to investors to securing long-term, happy tenants should be self-evident.

If we agree that changes need to be made to the rental system to help mitigate and reshape the reality of low affordability for those who choose to rent, whilst at the same time protect the interests of investors who provide the vast majority of private rental accommodation, it seems logical and rational to review some long unchallenged norms in the residential tenancy space.

Property Q&A

This week:

Are low-rate mortgages in foreign currencies too good to be true?

Property landlords deliver important commodity.

The wash on laundries

Will Geelong property motor on?

Mortgages in foreign currencies

As a non-resident Australian earning in euros, loans for Australian residential property are currently available at around 2.5% variable, with repayments in euros. This seems too good to be true. Is it?

It is the case that non-residents can borrow funds denominated in the currency where they reside to purchase Australian property. In these instances, the mortgage rate is based on the going rate for that currency, not the Australian dollar. With the European Central Bank rate close to zero, there are mortgage rates advertised as low as 2.5% for euro-denominated loans.

As well as being much lower than the 6%-6.5% interest for an equivalent Australian dollar loan, a euro-denominated loan for a Eurozone resident protects them from exchange rate fluctuations. In contrast, an Australian in Europe paying an Australian dollar-denominated loan with euro earnings would see their euro payments rise if the euro were to fall in value relative to the Australian dollar.

However, whilst borrowing euros might provide certainty in terms of cash flow, this scenario doesn’t remove the issue of exchange rate fluctuations altogether. Ultimately, your liability – the loan – is denominated in euros, whilst your asset – the Australian property – is denominated in Australian dollars. A major appreciation in the euro against the Australian dollar may see you owe more than your assets are worth.

Then there is the issue of asset selection for those seeking to buy quality property for investment purposes. Be very careful you apply appropriate asset selection criteria or appoint a local independent professional to do this on your behalf.

Property landlords deliver important commodity

Why do some commentators insist on portraying all landlords as parasites? To my mind, property is an ethical investment without any downside –buy a good property, charge a fair rent, and if something is broken, fix it.

I agree that there is a view in some quarters that caricatures investors as sponging off downtrodden tenants. Now whilst there are some isolated examples of slum investors – which are rightly given great prominence on evening current affairs shows – the overwhelming majority of investors are very responsible and respectful towards their tenants.

I absolutely agree with your point that investors deliver an important commodity to tenants in exchange for a fair rent. Tenants would face a far bleaker situation if they were reliant just on the public sector to provide rental accommodation, not to mention the impact on the public purse to create adequate stock that does not exist.

The wash on laundries

How important is it for a prospective investment unit to have its own laundry facilities, either within the property or in a common area?

Laundry facilities are desirable as the property will be more attractive to tenants and the property will rent faster and for a higher rent.

However, if absent, laundry facilities can always be installed or created somewhere in the bathroom or kitchen so their absence is by no means a deal breaker. I would certainly rank them as a lower priority on the selection criteria than the style of the apartment, the streetscape, the floor plan and car parking.

Will Geelong property motor on?

With the recent job losses at the Ford motor plant in Geelong, would you still see that regional town as a good location to own investment property?

For those with a limited investment budget – i.e. below $350,000 – such that it effectively excludes them from buying quality investment property in a major capital city, regional alternatives such as Geelong provide a means to get a foothold in property.

Whilst Geelong will never deliver the consistent capital growth of Melbourne or Sydney, it does have a broad enough economic and cultural base to absorb the losses of a major employer. So unless your interests are specifically tied to a direct relationship with Ford, you should be no worse off.

Nevertheless, given the compromises involved in buying in a regional area, look to pay down debt quickly in order to build equity that can be used to eventually enter a prime investment market.

Note: We make every attempt to provide answers to readers’ questions, however, answers are of a general nature only. Subscribers should seek independent professional advice for more in-depth information that is specific to their situation.

Monique Sasson Wakelin

Latest News

Related Articles

IMPORTANT: This information has been prepared without taking into account your objectives, financial situation or needs and you should consider if the information is appropriate for you before making an investment decision. Unless otherwise specifically stated or disclosed (such as the InvestSMART Diversified Portfolios Product Disclosure Statement), neither InvestSMART Financial Services Pty Ltd nor any of its Related Companies make any recommendations as to the merits of any investment opportunity referred to in its emails or its related websites. Product disclosure statements for financial products offered through InvestSMART can be downloaded from this website or obtained by contacting 1300 880 160. You should consider the product disclosure statement before making a decision about the product. All indications of performance returns are historical and can not be relied upon as an indicator for future performance.